One of the world's most influential investors has warned share markets are in the late stages of a massive bubble.
And that it will all end in tears very soon.
GMO co-founder Jeremy Grantham wrote in a letter to investors this week that the very long bull market that started in 2009 has now "matured" into a "fully fledged epic bubble".
"Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behavior, I believe this event will be recorded as one of the great bubbles of financial history – right along with the South Sea bubble, 1929, and 2000."
The S&P/ASX 200 Index (ASX: XJO) and S&P 500 Index (INDEXSP: .INX) have climbed 48% and 68% respectively since March.
Governments have poured in unprecedented support and central banks have erased interest rates to get the world through COVID-19. But none of that matters now, according to Grantham, because this bubble is about to burst.
"Make no mistake – for the majority of investors today, this could very well be the most important event of your investing lives," he said.
"Speaking as an old student and historian of markets, it is intellectually exciting and terrifying at the same time."
Grantham reminded his readers that the Nasdaq Composite (INDEXNASDAQ: .IXIC) fell 82% when the tech bubble popped 20 years ago.
"And here we are again, waiting for the last dance and, eventually, for the music to stop."
He took the unstoppable rise of Tesla Inc (NASDAQ: TSLA) as a demonstration of a bubble at play.
"As a Model 3 owner, my personal favorite Tesla tidbit is that its market cap, now over US$600 billion, amounts to over US$1.25 million per car sold each year versus US$9,000 per car for General Motors Company (NYSE: GM)," Grantham said.
"What has 1929 got to equal that?"
When will this bubble burst?
Trying to predict the end of a bubble is always a mug's game, according to Grantham. But he took a stab at when he thought share investors might get a rude wake-up call.
"My best guess as to the longest this bubble might survive is the late [northern] spring or early summer, coinciding with the broad rollout of the COVID vaccine," he said.
"At that moment, the most pressing issue facing the world economy will have been solved. Market participants will breathe a sigh of relief, look around, and immediately realise that the economy is still in poor shape, stimulus will shortly be cut back with the end of the COVID crisis, and valuations are absurd."
One big sign of a bubble imminently about to burst is a "rising hostility toward bears".
"In the last few months the hostile tone has been rapidly ratcheting up," said Grantham.
"The irony for bears though is that it's exactly what we want to hear. It's a classic precursor of the ultimate break – together with stocks rising, not for their fundamentals, but simply because they are rising."
According to Grantham, the bursting of a bubble is hard to pick because it often happens when conditions for stocks are still excellent.
"The great bull markets typically turn down when the market conditions are very favorable – just subtly less favorable than they were yesterday. And that is why they are always missed."
The entire financial industry is rigged to be bullish
Even with a crash looming, bears will always be in the minority, according to Grantham.
"Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in."
You would always see the big investment houses and fund managers be bullish because it's "good for business and intellectually undemanding".
"It is appealing to most investors who much prefer optimism to realistic appraisal, as witnessed so vividly with COVID," Grantham said.
"And when it all ends, you will as a persistent bull have overwhelming company. This is why you have always had bullish advice in a bubble and always will."
What to do with your shares to prepare for a bubble burst
A major feature of bubbles is a massive disparity between the valuations of different asset classes or sectors, according to Grantham.
This time around, this gap is between growth and value stocks.
"Those at the very cheap end include traditional value stocks all over the world, relative to growth stocks. Value stocks have had their worst-ever relative decade ending December 2019, followed by the worst-ever year in 2020, with spreads between growth and value performance averaging between 20 and 30 percentage points for the single year!"
Another disparity is between shares in the US and developing nations. Australian stocks often mimic the fortunes of the US market.
"Emerging market equities are at 1 of their 3, more or less co-equal, relative lows against the US of the last 50 years."
So Grantham recommends positioning your portfolio to take advantage of both of these imbalances.
"We believe it is in the overlap of these two ideas, value and emerging, that your relative bets should go, along with the greatest avoidance of US growth stocks that your career and business risk will allow."
